Affordable Housing Institute : US

As sensory creatures, all we ever perceive is the past, because every signal comes to us after the event which it reports.

All we know is what’s behind us

Our brains reinterpret this flurry of pass information into a seamless present, which works beautifully except when reporting cycles are misaligned, as in the flash of lightning preceding the clap of thunder, or the roar of a jet causing us to look to see it, not where it is now, but where it was when it made the boom that is only now reaching us across a gap of miles.

We hear it on the right, see it on the left

That same perception dislocation applies to markets. Buyers dream of the future (pessimists never win auctions). Markets exist in the present (the tumbling chaos of individual events). Transaction reports bring us news of the past. Every sale recorded today was agreed some weeks or months or even years before. When appraisers, whose canon of ethics and professional standards require them to have evidence for their conclusions, are seeking to find values for assets whose prices are in disequilibrium, they’re always projecting against a subset of the past – driving, as I like to put it, solely through the rear-view mirror, hoping that the road ahead will be a continuation of the straight-aways and curves just experienced.

The market is going up, but we see it in the past, going down?

Which it never is, as illustrated by this Wall Street Journal article:

Appraisals Roil Real Estate Deals

Conservative Approach to Home Pricing Makes It Harder to Refinance or Sell

By JAMES R. HAGERTY and RUTH SIMON

Appraisals are becoming one of the biggest obstacles for Americans trying to sell their homes, refinance their mortgages or tap into home-equity credit lines.

If you’re aiming out of the rear-view mirror, you’re more or less condemned to overshoot or undershoot; it would be the fluke of flukes to hit the target.

Appraising itself is more difficult with home prices fluctuating rapidly and transactions few and far between in some markets; sale prices from a few months back may no longer reliably indicate the value of nearby homes.

Good appraisers, more than most, are keenly aware that though their customers demand to-the-dollar precision, their valuations (which are always quite correctly called ‘estimates of value’) involve ineradicable uncertainty.

“If history is no longer valid, then it is very difficult to get good and accurate values,” said Mark Rattermann, an appraisal trainer in Indianapolis.

Bad enough we have uncertainty, what if truth is over there?

That too is a tension, because the commissioning customer wants accuracy, and will lean on the appraiser to give that accuracy, preferably in the commissioner’s favor:

During the housing boom, appraisers often complained of pressure from lenders to inflate home-value estimates to justify dubious mortgage lending.

The effect of lagging sales information, coupled with the natural human propensity to find patterns out of chaos (an evolutionary comparative advantage for humanity, by the way, which is why it’s so strongly wired into us; if you’re always puzzling out the world’s logic, you’re always learning and will beat species that don’t), means that appraisers develop a narrative of their markets. This one is rising, that one is falling. This one is turning the corner, that one is showing weakness. Anecdotal confirmation also plays its part. Ha ha, says the originator to the appraiser, that property you thought wasn’t worth more than $325,000? The buyer just flipped it for $390,000. The desire not to be shown up, coupled with the market’s decade of nothing but rises, gradually beat down the appraisers’ caution.

From the Wall Street Journal

When the data’s fragmentary, can we tell where the market is going?

Now, some people in the mortgage business — and some borrowers — say the pendulum has swung too far the other way.

Two years ago, the appraiser would be harangued by an originator table-pounding for a loan approval. Now it’s the Chief Risk Officer, or the TARP ambassador, wanting the appraiser to prove the property’s worth at least the appraised amount.

Taking their cues from lenders, appraisers are avoiding any estimate that could be deemed excessive. “I don’t want to stick my neck out,” said Mr. Rooney, the Phoenix appraiser.

The apparent reversals can be astonishing.

Patti Sanders, an aerospace engineer in Oakdale, Calif., knew prices were down sharply but said she was “flabbergasted” recently when her 3,100-square-foot Victorian home was appraised at $250,000, compared with $635,000 assayed two years earlier.

$250 or $635? You decide!
The Sanders home in Oakdale, Calif., which has been appraised
for much less than the owner feels it is worth.

Why does a homeowner care about the notional value of a home? It’s the same home before and after, isn’t it?

What differences does the appraised value make if you’re not moving?

Appraisal ties to financing, and that ties directly to consumer cost of capital, and consumer availability of capital:

The new estimate prompted a lender to reject her application for a refinancing that would have lowered her mortgage payments about $400 a month.

Now this is a highly perverse outcome. Ms. Sanders want to refinance (presumably at a lower price) with the result that next month she will need to pay $400 less than she pays this month. It is therefore indisputable that the new loan will be safer than the existing loan – yet the appraisal condition is acting as a barrier to that self-evidently wise move.

Lenders burned by huge losses from defaults now are pressing appraisers to be more conservative.

But, says the attentive reader, the current loan might be over-extended? Why should the new lender bail out the old? Correct, replies the blogger, and therefore if Ms. Sanders cannot get a sympathetic hearing from this lender, she ought to go back to her current lender.

I can’t refinance and cut my payments even though I’m more able to pay the new loan? Say what?

[Once upon a time, HUD had a multifamily refinancing insurance known as Section 223(a)(7), which existed solely to enable a borrower to swap a new, lower-payment FHA-insured loan for the current, higher-payment FHA-insured loan. I can remember running into some situations, where despite the evident logic of swapping a current risk for a lower future risk, a HUD field office's mortgage credit department rejected the (a)(7) refinancing because of an inadequate appraisal. Fortunately, appeals up one or two levels within HUD produced a reversal and led to the right outcome. - Ed.]

Refinancing is a mild kind of appraisal-uncertainty problem; the severe problem comes, of course, on sales.

Chris Rubis, a real-estate agent in Fairfield County, Conn., said one client recently accepted an offer of about $750,000 on a four-bedroom, four-bathroom home. But the appraisal, which was done by someone outside the local area, came in last week at $700,000. That might require the buyer to come up with more cash for a down payment.

Let’s consider what could happen here, starting with the mechanical.

A typical single-family loan is the least of three numbers:

1. Coverage-capped. A percentage of the borrower’s income.

2. Price-capped. A percentage of the sale price.

3. Value-capped. A stipulated Loan-to-value (LTV) ratio.

This being a typical single-family, the lender’s is probably at 80% LTV. At an appraised value of $750,000, the loan will be capped at $600,000; at $700,000 appraised, the loan will be $560,000 –- $40,000 less.

So now we have three possible outcomes:

1. Seller takes $50,000 lower price.

2. Buyer comes up with $190,000 of down payment, $40,000 more than originally anticipated.

3. A new or revised appraisal miraculously rediscovers the original $750,000 price, and the sale proceeds as negotiated.

Which do you think the seller and buyer are rooting for?

We’re rooting for the appraisers’ home team

Observe the importance of hard equity:

“It’s opened a whole new door for negotiation,” Mr. Rubis said.

Equity is hard when it can be contributed, as cash, by a buyer into a property. When the buyer has already put in the cash, equity becomes an intangible – the money I could realize (conditional verb) if I were to finance or sell (even more conditional verb).

Credit lines are also vulnerable. J.P. Morgan Chase & Co. recently froze one customer’s home-equity line of credit because, the bank said, his Manhattan apartment — a 2,650-square-foot three-bedroom, two-bedroom duplex with a terrace appraised at $1.475 million in 2005 — was worth just $600,000. Chase told the borrower, who asked not to be identified, that the lower credit line would remain in effect until a new appraisal could demonstrate the value was much higher than $600,000.

Not unreasonable at all. If you’re going spendthrift on the inheritance, to finance your wastrel lifestyle, we’d best be certain you have an inheritance to waste!

The borrower then paid for a new appraisal that pegged the property at $1.8 million.

Fragmentary glimpses of the highway, easily to make false linear interpolations.

“To protect borrowers and the bank, we use an automated appraisal system on our portfolio,” a Chase spokesman said. “The system has proven effective.”

Automated single-family appraisal eliminates bias, increases speed, and lowers transaction costs.

This sort of overvaluation has come up before,
And it has always been due To human error

Think of Zillow, an endless source of financial voyeurism to those who wish to use it that way. If markets are rational – which they are in the long run, if not the short, because they represent the accumulated decisions of thousands and millions of people acting independently and rationally by their own lights – then the price of my house ought to correlate somehow with the price of my neighbor’s.

“However, we encourage customers who think that the valuation is too low to order an appraisal and we will reimburse them … if it supports their claim.”

A good principle, and a good position by Chase. Appraisers are creatures of information.

In some cases, lenders are requiring that appraisals be based on sales closed within the past three months rather than the prior six-month norm, appraisers said. Some lenders are also asking for comparisons with at least one sale in the past 30 days.

They work with partial data. Give them more data, better data, and they will change their minds.

Chase will restore this borrower’s full credit line, he added.

Absolutely.

The situation became more complicated on May 1 when the appraisal industry adopted the Home Valuation Code of Conduct. These new rules apply to mortgages that will be owned or guaranteed by government-backed mortgage companies Fannie Mae and Freddie Mac, which recently have accounted for about two-thirds of all new home loans.

In other words, ‘effectively controlling the debt markets.’

Financial wizardry gives us control

Fannie and Freddie agreed to the code last year after New York Attorney General Andrew Cuomo accused them of failing to ensure that appraisers were shielded from pressure to inflate their estimates.

Give Mr. Cuomo his due; without actually having the standing to bring the claims he brought, he nevertheless identified a weak link in the appraisal chain, and used the bully pulpit to change the system.

The code bars loan officers, mortgage brokers or real-estate agents from any role in selecting appraisers.

Sounds good, doesn’t it?

It always sounds good in the drawings

[Continued tomorrow in Part 2.]

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